Whoa! Whoa! Whoa! Settle down bond market. What you think is happening is not what’s happening.
Welcome back to The Rum Rebellion. In today’s letter, we’re taking up the question of when a price is not a price. The subject is prompted by last week’s move in 10-year US bond yields. The yield on said 10-year US Treasuries went to 1.75% at one point, its highest level since January of 2020. So what?
This key price is supposed to contain a lot of information for financial markets. For example, if the bond yields are rising (and thus bond prices falling) because everyone expects it to be a rip-roaring American summer, then it ‘feels’ like good news. Vaccines are rolling out. Stimulus cheques have mailed. The smell of inflation is in the air.
And speaking of which, US Federal Reserve Chairman Jerome Powell told markets he doesn’t much care about inflation. That’s not EXACTLY what he said. But Powell, meeting the press after last week’s two-day meeting of the Federal Open Market Committee (FOMC), told reporters the Fed would let inflation run over 2% for a while, until he and his colleagues were confident the pandemic recovery was firmly in place and unemployment had declined.
That seems like good news, right? If the Fed is fair dinkum about not raising its target interest rates this year or next year, or even the year after, that OUGHT to be good news for stock markets. The entire growth and momentum trade of the last few years — especially since March of last year — has been based on cheap money.
When the ‘risk-free’ rate of return, as defined by the yield on government bonds, is low, it makes rational sense to find bigger returns, even if it means taking more risk. That’s exactly what you’ve seen — massive risk taking on future expected returns from tech stocks, SPACs, IPOs and NFTs, some of which may never generate a dollar’s worth of profits.
Yet the bond market wasn’t buying it. Yields move up. And as they did, tech stocks in the US took a beating. What gives? Take a look at the chart below.
Source: Federal Reserve Economic Data
The REAL yield on the 10-year US Treasury is still negative. The REAL yield is the nominal yield minus inflation. In REAL terms, yields have been negative since the pandemic took hold. The rise in nominal yields isn’t a REAL price.
Central bankers all over the planet have been suppressing prices. It started with quantitative easing, in which central bank money printing brought bond yields down and bond prices up. And in certain places (like Australia) it’s continued with yield curve control. The result?
The price of credit isn’t a real price. Highly leveraged economies — with lots of debt — need price fixing. If the price of credit went higher, you’d have less GDP growth and lower asset prices. Yields are kept from rising by central bank policies in order to keep financial asset prices high.
The price of gold and silver are also signals…
US Treasury yields would have to rise to something like 4% in nominal terms to have REAL yields go back near 2%. 4% nominal Treasury yields would wreak havoc on financial markets. ‘Havoc’ is not a precise term, mind you.
But the logic is sound: a higher cost of government borrowing and all borrowing keyed off the ‘risk-free’ rate is a giant brick to the windscreen of an economy that depends on credit expansion for growth. If the rise in longer-term bond yields is a sign that investors see more inflation coming and are thus selling bonds and demanding higher interest rates to lend money for a longer term, that’s a sea change in sentiment.
Let’s not get ahead ourselves though. If there’s one thing we’ve learned since the GFC, it’s not to underestimate the willingness of a financial establishment willing to do absolutely anything to perpetuate its position of power and privilege. If the bond market ‘rebels’ by pushing long-term yields higher, what’s to stop central banks from practicing yield curve control further ‘out on the curve’?
Well, nothing really. Only the theoretical limits of the size of a central bank’s balance sheet. And in theory, as far as we know, there is NO limit to how many fake dollars you can create with a computer. Maybe if the electricity goes out, you’d be in trouble. But otherwise, money is no object!
Except in the real world, money DOES appear to still be an object. Down at the local antique and coin store, you’ll pay a 30% premium over the spot price of silver to buy a single ounce of silver. The premium goes down as the volume of your order goes up. But that’s assuming large volume orders can be filled!
We’re hearing more anecdotes of online bullion dealers cancelling or delaying the fulfillment of larger orders of physical silver. That’s one of the subjects for next month’s issue of The Bonner-Denning Letter. Is there an actual silver squeeze going on? And if so, so what?
Here’s a hint: the price of gold and silver are also signals. Traditionally, they tell you something about inflation perceptions and/or the risk of sovereign debt. In the paper market and on commodity exchanges, the prices aren’t sounding any alarms. But are the paper prices the real prices?
In the physical market, if you plan to take delivery of physical silver, even in small quantities, you’re going to pay a sizeable premium over the paper price. Conclusion: the price isn’t the price. And when the price isn’t the price, something else is going on. But what? Stay tuned.
Editor, The Rum Rebellion
P.S: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you should take now to protect your wealth. Learn more.